Pricing with market power review questions

the car itself or for more “basic” options such as power steering and automatic transmission. 
Explain why. 
This can be explained as an instance of third-degree price discrimination. In order to 
use the model of third-degree price discrimination presented in the text, we need to 
assume that the costs of producing car options is a function of the total number of 
options produced and the production of each type of options affects costs in the same 
way. For simplicity, we can assume that there are two types of option packages, 
―luxury‖ and ―basic,‖ and that these two types of packages are purchased by two 
different types of consumers. In this case, the relationship across product types MR
1
= 
MR
2
must hold, which implies that: 
P
1 
/P
2
= (1+1/E
2
) / (1+1/E
1
) 
where 1 and 2 denote the luxury and basic products types. This means that the higher 
price is charged for the package with the lower elasticity of demand. Thus the pricing 
of automobiles can be explained if the ―luxury‖ options are purchased by consumers 
with low elasticities of demand relative to consumers of more ―basic‖ packages. 
7. How is peak-load pricing a form of price discrimination? Can it make consumers better 
off? Give an example. 
Price discrimination involves separating customers into distinct markets. There are 
several ways of segmenting markets: by customer characteristics, by geography, and by 
time. In peak-load pricing, sellers charge different prices to customers at different 
times. When there is a higher quantity demanded at each price, a higher price is 
charged. Peak-load pricing can increase total consumer surplus by charging a lower 
price to customers with elasticities greater than the average elasticity of the market as 
a whole. Most telephone companies charge a different price during normal business 
hours, evening hours, and night and weekend hours. Callers with more elastic 
demand wait until the period when the charge is closest to their reservation price.